(13) Income Taxes

Earnings from continuing operations before income taxes for 2012, 2011 and 2010 consisted of the following:

(Thousands of dollars)	2012		2011		2010

United States	$	88,301	$	76,025	$	50,278
Foreign		37,654		29,444		17,167

Total earnings before income taxes	$	125,955	$	105,469	$	67,445

The income tax provision for 2012, 2011 and 2010 consisted of the following:

(Thousands of dollars)	2012			2011			2010

Current:

U.S. federal and state income taxes	$	35,054		$	21,466		$	15,815
Foreign		12,324			8,465			6,663

Total current		47,378			29,931			22,478

Deferred:

U.S. federal and state income taxes		1,885			9,820			2,819
Foreign		(5,165	)		(254	)		(1,383	)

Total deferred		(3,280	)		9,566			1,436

Total	$	44,098		$	39,498		$	23,914

Cash payments for income taxes totaled $44.1 million, $30.5 million and $18.8 million for 2012, 2011 and 2010, respectively.

A reconciliation of the income tax provision as computed at the statutory U.S. income tax rate and the income tax provision presented in the consolidated financial statements is as follows:

(Thousands of dollars)	2012			2011			2010

Tax provision computed at statutory rate	$	44,084		$	36,914		$	23,606
Tax effect of:
Expenses for which no benefit was realized		492			702			202
Change in effective state tax rate		23			(6	)		13
Tax credit		(239	)		(733	)		(930	)
State taxes net of federal benefit		2,512			1,779			1,813
Benefit of manufacturing deduction		(3,093	)		(1,492	)		(1,127	)
Acquisition costs		2,437			1,919			-
Foreign operations		(1,217	)		520			530
Other, net		(901	)		(105	)		(193	)

Total provision for taxes	$	44,098		$	39,498		$	23,914

The American Taxpayer Relief Act of 2012, signed into law on January 2, 2013, extends retroactively the US R&D tax credit for the period January 1, 2012 through December 31, 2013. Although reinstated retroactively, since the enactment of this tax law occurred after December 31, 2012, the tax benefit of the US R&D tax credit for the year 2012 will be recognized in our financial results for the first quarter of 2013. This tax benefit is estimated to be $678,000.

Appropriate U.S. and foreign income taxes have been provided for earnings of foreign subsidiary companies that are expected to be remitted in the near future. The cumulative amount of undistributed earnings of foreign subsidiaries that the Company intends to permanently reinvest and upon which no deferred U.S. income taxes have been provided was $115.5 million at December 31, 2012, the majority of which has been generated in Argentina, Canada, and France. Upon distribution of these earnings in the form of dividends or otherwise, the Company may be subject to U.S. income taxes (subject to adjustment for foreign tax credits) and foreign withholding taxes. It is not practical, however, to estimate the amount of taxes that may be payable on the eventual remittance of these earnings after consideration of available foreign tax credits.

The primary components of the deferred tax assets and liabilities and the related valuation allowances are as follows:

(Thousands of dollars)	2012			2011

Deferred income tax assets:

Pension costs	$	43,788		$	36,430
Payroll and benefits		1,129			1,365
Accrued warranty expenses		1,906			1,425
Postretirement benefits		9,137			8,143
Accrued liabilities		261			591
Other, net		8,573			1,680

Total deferred income tax assets		64,794			49,634
Less valuation allowance		(4,779	)		(1,117	)

Total deferred income tax assets		60,015			48,517

Noncurrent deferred income tax liabilities:

Prepaid expenses		(792	)		(993	)
Depreciation		(33,781	)		(34,143	)
Inventories		(974	)		(1,758	)
Intangible assets		(17,527	)		(8,784	)
Liability for unremitted earnings		(12,005	)
Other, net		(210	)		(5,585	)

Total noncurrent deferred income tax liabilities, net		(65,289	)		(51,263	)

Total net deferred tax liability	$	(5,274	)	$	(2,746	)

Current deferred tax asset	$	574		$	1,140

Non-current deferred tax liability		(5,848	)		(3,886	)

Total net deferred tax liability	$	(5,274	)	$	(2,746	)

At December 31, 2012, 2011 and 2010 there are $5.6 million, $2.1 million and $1.8 million, respectively, of unrecognized tax benefits. Of these amounts, $3.0 million, $2.1 million, and $1.8 million, respectively, represent the amounts of unrecognized tax benefits that, if recognized, would favorably affect the net effective income tax rate in any future period. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

(Thousands of dollars)	2012			2011			2010

Balance at January 1,	$	2,060		$	1,838		$	1,509

Gross increases- current year tax positions		4,255			791			372
Gross increases- tax positions from prior periods		3			115			233
Gross decreases- tax positions from prior periods		(683	)		(657	)		(262	)
Settlements		-			(27	)		(14	)

Balance at December 31,	$	5,635		$	2,060		$	1,838

In connection with the Datac acquisition the Company identified uncertain tax liabilities of the target company related to previous tax years. As a result, the Company entered into an agreement whereby the former owners funded an escrow account for $5.5 million dollars. In accordance with ASC 805, Business Combinations, the Company has identified an indemnification asset resulting from this agreement.

The Company conducts business globally and, as a result, Lufkin Industries, Inc. and its subsidiaries file income tax returns in the U.S. federal and state jurisdictions, and various foreign jurisdictions. For U.S. federal purposes, tax years prior to 2009 are closed to assessment. Statutes for years prior to 2009 remain subject to review in certain U.S. state jurisdictions; however, the outcome of any future audit is not expected to have a material effect on the Company's results of operations. The Company also remains subject to income tax examinations in the following material international jurisdictions: Canada (2009-2011), France (2010-2011), Argentina (2006– 2011) and United Kingdom (2011).

The Company has unrecognized tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within the next twelve months. The unrecognized tax benefits relate to tax credits and other various deductions. The Company estimates the change to be approximately $1,900,000.

The Company's continuing policy is to recognize interest and penalties related to income tax matters in administrative costs. The Company had $100,000 accrued for interest and penalties at December 31, 2012. Net penalty and interest income of $10,000 and $45,000 were recognized in December 31, 2012 and 2011 respectively. Net penalty and interest expense of $30,000 was expensed in December 31, 2010.